PART II – OFFERING CIRCULAR

Preliminary Offering Circular

An offering statement pursuant to Regulation A relating to these securities has been filed with the Securities and Exchange Commission. Information contained in this Preliminary Offering Circular is subject to completion or amendment. These securities may not be sold nor may offers to buy be accepted before the offering statement filed with the Commission is qualified. This Preliminary Offering Circular shall not constitute an offer to sell or the solicitation of an offer to buy nor may there be any sales of these securities in any state in which such offer, solicitation or sale would be unlawful before registration or qualification under the laws of any such state. We may elect to satisfy our obligation to deliver a Final Offering Circular by sending you a notice within two business days after the completion of our sale to you that contains the URL where the Final Offering Circular or the offering statement in which such Final Offering Circular was filed may be obtained.

SUBJECT TO COMPLETION, DATED JANUARY 15, 2019

IRON BRIDGE MORTGAGE FUND, LLC

9755 SW Barnes Road, Suite 420

Portland, Oregon 97225

(503) 225-0300

Best Efforts Offering of

$50,000,000

SENIOR SECURED DEMAND NOTES

___________________

Iron Bridge Mortgage Fund, LLC (the “Company”), which does business as Iron Bridge Lending, engages in the business of making commercial purpose loans by lending funds to real estate investors to finance the ownership, entitlement, development or rehabilitation of residential and commercial real estate or for real estate-related purposes throughout the United States. The Company is not an investment company and investors will not have the protections provided under the Investment Company Act of 1940.

This Offering Circular relates to the offer and sale on a best efforts basis of up to an aggregate of $50,000,000 of the Company’s Senior Secured Demand Notes (“Senior Notes”). The offering will commence as soon as this Offering Circular has been qualified by the United States Securities and Exchange Commission and will remain open until the Company has sold Senior Notes with an aggregate purchase price of $50,000,000, unless earlier terminated in the Company’s sole discretion. Senior Notes will be sold at a price equal to the principal amount of such Senior Note, subject to a minimum investment of $50,000; provided that the Company’s Manager, in its sole discretion, may waive this requirement with respect to any investor. See “Description of Senior Notes” on Page 77 and “Plan of Distribution” on Page 81 this Offering Circular.

Generally, no sale may be made to you in this offering if the aggregate purchase price you pay is more than 10% of the greater of your annual income or net worth. Different rules apply to accredited investors and non-natural persons. Before making any representation that your investment does not exceed applicable thresholds, we encourage you to review Rule 251(d)(2)(i)(c) of Regulation A. For general information on investing, we encourage you to refer to www.investor.gov.

Investing in the Senior Notes involves a high degree of risk, including risks associated with income tax, use of proceeds and conflicts of interest. Before buying any Senior Notes, you should carefully read the discussion of material risks of investing in the Senior Notes in “Risk Factors” beginning on Page 5 of this Offering Circular. This Offering Circular supersedes any prior offering circular with respect to the Senior Notes.

THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION DOES NOT PASS UPON THE MERITS OF OR GIVE ITS APPROVAL TO ANY NOTES OFFERED OR THE TERMS OF THE OFFERING, NOR DOES IT PASS UPON THE ACCURACY OR COMPLETENESS OF ANY OFFERING CIRCULAR OR OTHER SOLICITATION MATERIALS. THESE NOTES ARE OFFERED PURSUANT TO AN EXEMPTION FROM REGISTRATION WITH THE COMMISSION; HOWEVER, THE COMMISSION HAS NOT MADE AN INDEPENDENT DETERMINATION THAT THE NOTES OFFERED ARE EXEMPT FROM REGISTRATION.

(1)	The Senior Notes will be issued in a principal amount based on the individual investment.
(2)	We do not intend to use commissioned sales agents or underwriters.
(3)	Represents net proceeds to the Company before deducting our expenses related to the offering, including legal fees, accounting, printing and distribution expenses. See “Use of Proceeds” on Page 19.

The date of this Offering Circular is _______________

The Company is following the disclosure format prescribed by Part II of Form 1-A.

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OFFERING CIRCULAR SUMMARY

This summary highlights information contained elsewhere in this Offering Circular. This summary does not contain all of the information you should consider before deciding whether to purchase our Senior Notes. The summary is subject to, and qualified in its entirety by reference to, the detailed provisions of this Offering Circular, and the other agreements associated with this offering. You should carefully read this entire Offering Circular, including the information under the heading “Risk Factors.” References to “we,” “us” or “our” mean Iron Bridge Mortgage Fund, LLC.

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RISK FACTORS

Investing in our Senior Notes involves a high degree of risk. You should carefully consider the following risk factors together with all of the other information included in this Offering Circular in evaluating an investment in the Company’s Senior Notes. If any of the following risks were to occur, the Company’s business, financial condition, results of operations, cash flows and ability to make cash distributions could be materially adversely affected, and you could lose part or all of your investment.

Risks Related to the Offering and the Senior Notes

The Senior Notes are not insured or guaranteed by the FDIC or any third party, so repayment of the Senior Notes depends upon the collateral securing our Portfolio Loans and our ability to manage our business so as to generate adequate cash flows to repay the Senior Notes.

The Senior Notes are not certificates of deposit or similar obligations or guaranteed by any depository institution and are not insured by the FDIC or any governmental or private insurance fund, or any other entity. Therefore, you are dependent upon our ability to manage our business so as to generate adequate cash flows to repay the Senior Notes. If we are unable to generate sufficient cash flow to repay the Senior Notes, you could lose your entire investment.

There will not be any market for the Senior Notes, so you should only purchase them if you do not have any need for your money prior to the maturity of the Senior Note.

The Senior Notes are not listed on a national securities exchange or authorized for quotation on the NASDAQ Stock Market or any securities exchange. Accordingly, there will be no trading market for the Senior Notes. Except as described elsewhere in this Offering Circular, you have no right to require early redemption of the Senior Notes prior to the Maturity Date. You should only purchase these Senior Notes if you do not have the need for your money prior to the maturity of the Senior Note.

There is no sinking fund to ensure repayment of the Senior Notes at maturity, so you are totally reliant upon our ability to generate adequate cash flows to repay the Senior Notes.

We do not contribute funds to a separate account, commonly known as a sinking fund, to repay the Senior Notes upon maturity. Because funds are not set aside periodically for the repayment of the Senior Notes over their respective terms, you must rely on our consolidated cash flows from operations, investing and financing activities and other sources of financing for repayment, such as funds from loan repayments, and other borrowings. To the extent cash flows from operations and other sources are not sufficient to repay the Senior Notes, you may lose all or part of your investment.

We may not generate sufficient distributable cash flow to support the payments required by the Senior Notes. As such there is no guaranteed return of your investment.

The Senior Notes offered hereby are speculative and involve a high degree of risk. There can be no guarantee that you will realize a substantial return on the Senior Notes, or any return at all, or that you will not lose your entire investment. For this reason, you should read this Offering Circular carefully and should consult with your own legal counsel, accountants, or business advisors prior to making any investment decision. We must generate a certain amount of revenue in order to make the payments we are obligated to make under the Senior Notes. The amount of cash we can pay on our Senior Notes principally depends upon the amount of cash we generate from our operations, which will fluctuate from month to month based on, among other things:

	·	the payments received on our Portfolio Loans;
	·	the levels of our operating expenses, general and administrative expenses and capital expenditures;

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	·	the fees and expenses of our Manager and its affiliates that we are required to reimburse;
	·	the amount of cash reserves established by our Manager;
	·	the amount of capital we are able to raise and implement towards our operating strategy; and
	·	other business risks affecting our cash levels.

In addition, the actual amount of cash flow that we generate will depend on other factors, some of which are beyond our control, including:

	·	overall domestic and global economic and industry conditions;
	·	the price and availability of alternative lending sources for our Portfolio Borrowers;
	·	competition from other lenders; and
	·	the impact of governmental laws and regulations.

The Senior Notes are and will be subordinated to Bank Borrowings.

The Senior Notes are senior to the Company’s existing Junior Notes and equity interests, and subordinate to the Company’s Bank Borrowings or any replacement or addition to such borrowings. See “Financial Statements” beginning on Page F-1 for information regarding Junior Notes, equity interests and Bank Borrowings. The Senior Note Purchase Agreement that governs the terms of the Senior Notes does not have any restrictions on our ability to incur senior, secured Bank Borrowings other than the Maximum Debt Covenant. Consequently, in the event of our bankruptcy, liquidation, dissolution, reorganization or similar proceeding, the holders of any senior secured indebtedness will be entitled to proceed against the collateral that secures such indebtedness and such collateral will not be initially available for satisfaction of any amounts owed under the Senior Notes, and the debt held by our senior lenders to which the Senior Notes are subordinated will be entitled to be paid in full prior to any right of Senior Noteholders to receive payment.

We may be unable to repay the Senior Notes at maturity or upon default.

On the Maturity Date of a Senior Note, or in the event of a default under the Senior Note Purchase Agreement, Senior Notes or Security Agreement, the Company may not have sufficient funds available at such time to make the required repayment of the principal and accrued and unpaid interest on the Senior Notes. In addition, the loan agreements for our Bank Borrowings contain, and any future credit agreements or other agreements relating to our Bank Borrowings may contain, provisions prohibiting the repayment of the Senior Notes under certain circumstances, or may provide that a designated event constitutes an event of default under that agreement. At maturity, the Manager, in its sole discretion, may extend the Maturity Date by up to three months. If the Company extends the Maturity Date, payment of the Senior Notes would be delayed until that date. If the Company receives demands for payment from Senior Noteholders collectively holding more than thirty percent (30%) of the unpaid principal amounts of all outstanding Senior Notes, the Company may elect to extend the Maturity Date for all Senior Notes while the Company liquidates and winds up its Portfolio Loans. If any agreement governing the Company’s indebtedness prohibits the Company from repaying the Senior Notes when obligated to do so, the Company could seek the consent of the lenders to repay the Senior Notes or attempt to refinance this debt. If the Company does not obtain such consent to refinance the debt, the Company would not be permitted to repay the Senior Notes. The Company’s failure to repay Senior Notes would constitute an Event of Default, which might constitute a default under the terms of our other indebtedness.

A Majority of Interest is necessary to accelerate payments under the Senior Notes

If an Event of Default occurs, your remedies may be limited. A Majority of Interest may, on behalf of all Senior Noteholders accelerate payment under the Senior Notes to exercise and enforce their rights, as provided under the Security Agreement. Furthermore a Majority of Interest may elect to waive such rights and remedies in their discretion. A Senior Noteholder, acting alone, will have no recourse to accelerate payment under the Senior Notes, unless they individually hold a Majority of Interest. If an Event of Default occurs and a Majority of Interest waives or otherwise declines to enforce your rights and remedies under your Senior Note, you will be without recourse with respect to such Event of Default. A Senior Noteholder may contact the Collateral Agent pursuant to the Security Agreement, to coordinate a Majority of Interests, but there is no guarantee that a Majority of Interest will elect to accelerate payment of the Senior Notes.

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The Company is permitted to incur more debt, which may intensify the risks associated with current leverage, including the risk that the Company will be unable to service its debt.

The Senior Note Purchase Agreement does not prohibit the Company from incurring any indebtedness or other liabilities except to the extent borrowings exceed the Maximum Debt Covenant. If the Company incurs additional debt, the risks associated with its leverage, including the risk that the Company will be unable to service its debt, will increase.

The Manager has wide discretion to redeem equity interests in the Company prior to the maturity of the Senior Notes and to repurchase Senior Notes prior to maturity.

Under the terms of the Company’s Operating Agreement and the Senior Notes, the Manager may repurchase equity interests in the Company or prepay the Senior Notes under certain circumstances. If the Manager chooses to use Company cash to redeem equity interests in the Company or to prepay certain Senior Notes, Senior Noteholders face the risk of the Company being unable to pay the Senior Notes at maturity. Following a redemption or prepayment, the Company may have less cash available for payment of debt on its terms at maturity. If the Company is unable to continue to generate cash flow or asset values diminish following a redemption or prepayment, Senior Noteholders face a greater risk of loss of investment.

The Collateral securing repayment of the Senior Notes may be insufficient.

Although the Senior Notes will be secured by an interest in the assets of the Company which is senior to that of Junior Noteholders and the Company’s equity owners, such security interest is subordinate to Bank Borrowings, as well as to statutorily protected interests, such as liens in connection with unpaid taxes and construction liens. The terms of the Bank Borrowings and any subsequent borrowings may also impose certain conditions on existing Senior Noteholders with respect to the exercise of remedies in the event the Company is in default under Bank Borrowings or such subsequent borrowings. Therefore, there is no assurance that the Senior Noteholder’s security interest will be perfected in seniority over the interests of other creditors of the Company in such assets, that its remedies will be enforceable, or if such Collateral is foreclosed upon, that it will be sufficient to repay the Senior Notes.

The Company may change the rate of interest payable on the Senior Notes at any time.

Each Senior Note will bear simple interest on the unpaid principal amount of the Senior Note at a rate of six percent (6%) interest per annum. The Company may change the interest rate at any time, provided that (i) the interest rate may not be increased or decreased by more than one-half percent (0.5%) at the time of any change, and (ii) the interest rate change is applied to all Senior Notes outstanding. The Company will provide written notice to each Senior Noteholder before making any change in the interest rate and the rate change will not become effective until 90 days after the notice. If the interest rate is decreased, Senior Noteholders may receive less income from the Senior Notes than they would have had the interest rate stayed the same or increased. In the event the Company changes the interest rate, Senior Noteholders may demand payment of their Senior Notes prior to the date when the interest rate change becomes effective.

 

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Senior Noteholders will not have the protection of a trustee, an indenture or the provisions of the Trust Indenture Act of 1939.

Because this offering is being made in reliance on an exemption from registration under the Securities Act, it is not subject to the Trust Indenture Act of 1939. Consequently, purchasers of Senior Notes will not have the protection of an indenture setting forth obligations of the Company for the protection of the Senior Noteholders or a trustee appointed to represent their interests.

You will not have the benefit of an independent review of the terms of the Senior Notes, the Offering Circular or our Company as is customarily performed in underwritten offerings.

The Senior Notes are being offered by us on a “best efforts” basis without an underwriter or placement agent. Therefore, you will not have the benefit of an independent review of the terms of the Senior Notes, the Offering Circular, or our Company. Accordingly, you should consult your investment, tax, and other professional advisors prior to deciding whether to invest in the Senior Notes.

We are conducting this offering on a “best efforts” basis.

This offering is being conducted on a “best efforts” basis by the Manager only. No guarantee can be given that all or any of the Senior Notes will be sold, or that sufficient proceeds will be available to conduct successful operations. The Company can retain any proceeds from the sale of the Senior Notes sold in this offering. Accordingly, all funds raised in the offering will become immediately available to the Company and may be used as they are accepted.

This offering is being made subject to Regulation A under the Securities Act (“Regulation A”), which has recently undergone significant changes.

The Company is conducting this offering pursuant to Regulation A, which was amended effective June 19, 2015. Because of these recent amendments, there is still significant uncertainty with respect to the parameters of an offering pursuant to this regulation. In addition, these regulations may change as regulators develop practices with respect to such amendments, which changes may be detrimental to the Company or its ability to raise funds. If the Company were to inadvertently violate the parameters of this type of offering, it may be subject to enforcement action or civil liabilities under securities laws. Such violation may also affect the Company’s ability to raise capital in the future.

Risks Related to the Business

Any deterioration in the housing industry or economic conditions could result in a decrease in demand and pricing for new and rehabilitated residential properties, which would have a negative impact on our business and could reduce the likelihood we will be able to generate enough cash to repay the Senior Notes.

The Portfolio Borrowers to whom we make loans use the proceeds of our loans to construct or rehabilitate residential properties. The developers obtain the money to repay our loans by selling the residential properties they have constructed or rehabilitated. A Portfolio Borrower’s ability to repay our loans is based primarily on the amount of money generated by selling the properties they have constructed or rehabilitated, and thus, the Portfolio Borrowers’ ability to repay our loans is based primarily on the amount of money generated by the sale of such properties.

The housing industry is cyclical and is significantly affected by changes in industry conditions, as well as in general and local economic conditions, such as:

	·	employment level and job growth;
	·	demographic trends, including population increases and decreases and household formation;

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	·	availability of financing for homebuyers;
	·	interest rates;
	·	affordability of residential properties;
	·	consumer confidence;
	·	levels of new and existing residential properties for sale, including foreclosed properties and properties held by investors and speculators; and
	·	housing demand generally.

These conditions may occur on a national scale or may affect some of the regions or markets in which we operate more than others.

We generally lend a percentage of the values of the residential properties our Portfolio Borrowers are building or rehabilitating. These values are determined shortly prior to loan funding. If the values of properties in markets in which we lend drop fast enough to cause the Portfolio Borrowers losses that are greater than their equity in the property, we may be forced to liquidate the loan in a fashion that will cause us to lose money. If these losses when combined and added to our other expenses are greater than our revenue from interest paid by our Portfolio Borrowers, it may impair our ability to pay interest on the Senior Notes and repay the principal on the Senior Notes. Values are typically affected by the demand for and supply of properties, which can change due to many factors, including but not limited to, demographics, interest rates, cost of building materials and labor, availability of financing, inventory of homes available and governmental action or inaction. Any tightening of credit markets would make it more difficult for potential homeowners to obtain financing to purchase homes. If housing prices decline or sales in the housing market decline, our Portfolio Borrowers may have a hard time selling their homes at a profit. This could cause the number of defaulted loans that we will own to increase. An increase in defaulted loans would reduce our revenue and could lead to losses on our loans. A decline in housing prices will further increase our losses on defaulted loans. If the amount of defaulted loans or the loss per defaulted loan is large enough, we will operate at a loss, which will decrease our equity. This could cause us to become insolvent, and we will not be able to pay back your investment in the Senior Notes.

We have a limited operating history on which to base your investment decision.

The Company began making investment loans as Iron Bridge Mortgage Fund, LLC on April 1, 2009. Although the Manager and its Managing Directors may have achieved favorable returns with some of its previous Portfolio Loans, the performance of past investments cannot be relied upon to predict the Company’s success.

Our operations are not subject to the stringent banking regulatory requirements designed to protect investors, so repayment of your investment is completely dependent upon the successful operation of our business.

Our operations are not subject to the regulatory requirements imposed upon the operations of commercial banks, savings banks, and thrift institutions, and are not subject to periodic compliance examinations by federal or state banking regulators. For example, we will not be well diversified in our product risk, and we cannot benefit from government programs designed to protect regulated financial institutions. Therefore, an investment in the Senior Notes does not have the regulatory protections that the holder of a demand account or a certificate of deposit at a bank does. The return on Senior Notes purchased by a Senior Noteholder is completely dependent upon the successful operation of our business. To the extent that we do not successfully operate our business, our ability to pay interest and principal on the Senior Notes will be impaired.

If the proceeds from the issuance of the Senior Notes exceed the cash flow needed to fund the desirable business opportunities that are identified, we may not be able to invest all of the funds in a manner that generates sufficient income to pay the interest and principal on the Senior Notes.

Our ability to pay interest on our debt, including the Senior Notes, pay our expenses, and cover loan losses is dependent upon interest and fee income we receive from loans extended to our Portfolio Borrowers. If we are not able to lend to a sufficient number of Portfolio Borrowers at high enough interest rates, we may not have enough interest and fee income to meet our obligations, which could impair our ability to pay interest and principal to you. If money brought in from new Senior Notes and from repayments of loans from our Portfolio Borrowers exceeds our short term obligations such as expenses, Senior Note interest and redemptions, and line of credit principal and interest, then it is likely to be held as cash, which will have a lower return than the interest rate we are paying on the Senior Notes. This will lower earnings and may cause losses which could impair our ability to repay the principal and interest on the Senior Notes.

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Our cost of funds is substantially higher than that of banks.

Because we do not offer FDIC insurance, and because we want to grow our Senior Notes faster than most banks want to grow their CD base, our Senior Notes offer significantly higher rates than bank CDs. As a result, our cost of funds is higher than banks’ cost of funds. This may make it more difficult for us to compete against banks when they rejoin our niche lending market in large numbers. This could result in losses which could impair or eliminate our ability to pay interest and principal on our outstanding Senior Notes.

Our investments are determined from time to time by the Manager, with no input from Senior Noteholders.

A Senior Noteholder must rely upon the ability of the Manager to identify, structure and implement Portfolio Loans consistent with the Company’s investment objectives. Accordingly, no person should purchase Senior Notes from the Company unless he or she is willing to entrust all aspects of the management, financing, and development of a Project to the Portfolio Borrower, and the management of the Company, valuation of the Projects and the terms of the Portfolio Loans to the Manager.

There can be no assurance that loans of a suitable nature will be available in the market. It is possible that the Company will be less invested in Portfolio Loans than we expect, if sufficiently attractive loan opportunities are not identified.

We may be subject to risks resulting from conflicts of interest between the Company and the Manager and its principals and affiliates.

There may be certain conflicts of interest between the Company and the Manager, its principals and their affiliates. These include:

	·	Time Demands. The Manager’s primary business activity during the life of the Company is the management of the Company. However, the Manager or its Managing Directors may pursue investment and lending activities away from the Company. Their interests and activities in connection with such other investments may create a conflict with the Company’s interests.
	·	Disproportionate Interest of Manager. The Company’s Manager receives management fees that are proportionally greater than the interest payable to Senior Noteholders. Accordingly, the Manager’s risk profile with respect to the use of the Company’s capital may diverge from that of the Senior Noteholders.
	·	Potential Conflicts of Interest. The Manager may encounter various potential and actual conflicts of interest between itself and the Company in the event that the Manager sponsors other mortgage funds or is required under other lender loan covenants to purchase non-performing assets from the Company.

See “Conflicts of Interest” on Page 79 for greater details about these conflicts.

Additional competition may decrease our profitability, which would adversely affect our ability to repay the Senior Notes.

We may experience increased competition for business from other companies and financial institutions that are willing to extend the same types of loans that we extend at lower interest rates and/or fees. These competitors also may have substantially greater resources, lower cost of funds, and a better established market presence. If these companies increase their marketing efforts to our market niche of borrowers, or if additional competitors enter our markets, we may be forced to reduce our interest rates and fees in order to maintain or expand our market share. Any reduction in our interest rates, interest income or fees could have an adverse impact on our profitability and our ability to repay the Senior Notes.

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We are heavily dependent on the Manager and its Managing Directors, the loss of which may have a significant impact on operations.

The Manager will make all management decisions for the Company, including Portfolio Loan selection. The Company will be relying in large part on the Manager’s loan origination expertise. The Manager may resign at any time without liability to the Company. If the Manager withdraws from the Company, is terminated by the Company’s equity owners for cause or otherwise, or is terminated as Manager by dissolution or bankruptcy, it may be difficult or impossible for the Company to locate a suitable replacement for the Manager. In addition, two of the Manager’s Managing Directors, Gerard Stascausky and Sarah Gragg Stascausky, are considered an integral part of the Company’s investments and operations. If either or both Managing Directors were to leave the Manager, die or become permanently disabled, the Manager’s ability to continue the management of the Company would be materially and adversely affected.

We may become liable for indemnification obligations to our Manager or its affiliates.

The Company will be required to indemnify the Manager and certain affiliated persons and entities of the Manager for liabilities incurred in connection with the affairs of the Company. Such liabilities may be material and have an adverse effect on the ability to pay the Senior Noteholders. The indemnification obligation of the Company will be payable from the assets of the Company.

The value of the collateral securing a Portfolio Loan may be incorrectly determined by the Manager.

The Manager will develop and utilize a consistent method to estimate the value of the collateral for each Portfolio Loan, in the Manager’s sole discretion. The Manager will use methodologies that it deems reasonable based on various valuation practices commonly used in similar businesses in the industry including broker price opinions, comparative market analyses, appraisals, comparable sales of other similar assets, historical data and trends from actual sales, disposition or performance of assets, cash balances (in the case of cash assets), and other such methodologies generally used and accepted in the market. The determination or estimation of the value of any real estate collateral or other asset is highly subjective and subject to change continuously on an ongoing basis. There is no guarantee that any value as determined by the Manager of any real estate collateral or other asset of the Company will be accurate or represent the true current value of any asset.

The collateral securing our Portfolio Loans may not be sufficient to pay back the principal amount in the event of a default by the borrowers.

In the event of default, our real estate loan investments are generally dependent entirely on the loan collateral securing our Portfolio Loans to recover our investment. Our loan collateral consists primarily of a deed of trust or mortgage on the underlying property. In the event of a default, we may not be able to recover the property promptly and the proceeds we receive upon sale of the property may be adversely affected by risks generally related to interests in real property, including changes in general or local economic conditions and/or specific industry segments, declines in real estate values, increases in interest rates, real estate tax rates and other operating expenses including energy costs, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, and other factors which are beyond our or our Portfolio Borrowers’ control. Current market conditions may reduce the proceeds we are able to receive in the event of a foreclosure on our loan collateral. Our remedies with respect to the loan collateral may not provide us with a recovery adequate to recover our investment.

 

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There is no assurance that our current financing arrangements will remain in place.

We will depend on Bank Borrowings to fund our Portfolio Loans and reach our target leverage ratio. Accordingly, our ability to achieve our investment and leverage objectives depends on our ability to borrow money in sufficient amounts and on favorable terms. Currently, we have entered into a $25 million line of credit with Western Alliance Bank. There can be no assurance that this agreement will remain in place and, even if in place, that the amount and definitive terms under which we would be able to borrow would be adequate. Adverse developments in the residential and commercial mortgage markets could make it more difficult for us to borrow money to finance our operations.

We are subject to significant government regulation, which may affect our ability to operate.

The industry in which the Company is an active participant may be highly regulated at both state and federal levels. The Company will attempt to comply with all applicable regulations affecting the markets in which it operates. However, such regulation may become overly burdensome and therefore may have a negative effect on the Company’s ability to perform. The Company expects to comply with all rules, regulations, advisories and guidelines, however it is extremely difficult to keep up with all changes and proposed changes to all federal and state regulations at all times, and the Company may, on occasion, be delayed in such compliance, requiring the Company to pay penalties, costs, fees, and other charges to regain compliance. Any such penalty, cost, fee, or other charge will negatively impact the Company and its ability to pay Senior Noteholders.

We may become subject to the Investment Company Act, which could interfere with our intended operations.

The Company intends to operate so as to not be regulated as an investment company under the Investment Company Act of 1940 (the “Investment Company Act”) based upon certain exemptions thereunder. Specifically, the Company expects to be exempted from registration under the Investment Company Act because the Company will be primarily engaged in purchasing or acquiring mortgages and other liens on, and interests in, real estate as determined under exemptions from the Investment Company Act and rules issued thereunder. Accordingly, the Company does not expect to be subject to the restrictive provisions of the Investment Company Act. However, if the Company fails to qualify for exemption from registration as an investment company, its ability to conduct its business as described herein will be compromised. Any such failure to qualify for such exemption would likely have a material adverse effect on the Company.

Our reliance on certain exclusions from the Investment Company Act may impact certain investment decisions.

The Investment Company Act excludes from the definition of an “investment company” issuers of non-redeemable securities that are primarily engaged in purchasing or otherwise acquiring mortgages and other liens on, and interests in, real estate. The Manager has not sought a no-action letter from the SEC to confirm that the Company is eligible for this exemption. However, the Manager will rely on guidance issued by the SEC stating that so long as (1) qualifying percentages of the Company’s assets consist of mortgages and other liens on or interests in real estate; and (2) the remaining percentage of the Company’s assets consist primarily of real estate related assets, the Company will remain exempt from the Investment Company Act registration requirements. These formulaic requirements may negatively impact the Company’s investment flexibility and the ability of the Manager to invest in other funds, limited partnerships, limited liability companies, and other similar vehicles.

We may become subject to additional regulations that may interfere with our operations.

Federal and state lawmakers and regulators may take action to increase or otherwise modify the laws, rules and regulations applicable to techniques and instruments in which the Company may invest. New (or modified) laws, rules and regulations may prevent, or significantly limit the ability of, the Manager from using such instruments or from engaging in such transactions. This may impair the ability of the Manager to carry out the Company’s investment strategy and may otherwise have an adverse impact on the Company’s business. Compliance with such new or modified laws, rules and regulations may also increase the Company’s expenses and therefore may adversely affect the Company’s performance. It is not possible at this time to predict with certainty what, if any, impact any new or modified regulations will have on the Manager or the Company, and it is possible that such impact could be adverse and material.

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Real estate investing is inherently risky.

The Company is subject to the risks that generally relate to investing in real estate because it principally makes debt investments in real estate assets. Real estate historically has experienced significant fluctuations and cycles in performance that may result in reductions in the value of the Company’s real estate-related investments. The performance and value of its investments once acquired depends upon many factors beyond the Company’s control. The ultimate performance and value of the Company’s investments are subject to the varying degrees of risk generally incident to the ownership and operation of the properties in which the Company invests and which collateralize or support its investments.

In addition, the Company will regularly make loans to Portfolio Borrowers who will borrow Company assets to invest in “rehab and flip” properties. Because these properties are in need of rehabilitation and refurbishment, often before such properties are habitable or tenantable, there is little to no accurate guidance as to the value of such properties. Such lack of guidance may impact our underwriting and cause us to advance more on a loan than such a property is worth. Further, such properties are subject to a number of independent, unique, or increased risks, including, but not limited to, unlicensed and unbonded contractors, delayed payments, faulty or shoddy workmanship of third parties, inability or delays in permitting or final approvals, lack of or inadequate insurance coverage, delay in resale, significant price reduction upon resale, requiring the Company to seize or retake the property in an event of default, loss of loan principal, and other risks.

The ultimate performance and value of the Company’s investments will depend upon, in large part, the Portfolio Borrower’s or the Company’s ability to operate any given property so that it produces sufficient cash flows necessary to pay the interest and principal due to the Company on its Portfolio Loans. Revenues and cash flows may be adversely affected by: changes in national or local economic conditions; changes in local real estate market conditions due to changes in national or local economic conditions or changes in local property market characteristics, including, but not limited to, changes in the supply of and demand for competing properties within a particular local property market; competition from other properties offering the same or similar services; changes in interest rates and the credit markets which may affect the ability to finance, and the value of, investments; the ongoing need for capital improvements, particularly in older building structures; changes in real estate tax rates and other operating expenses; changes in governmental rules and fiscal policies, civil unrest, acts of God, including earthquakes, hurricanes and other natural disasters, acts of war or terrorism, which may decrease the availability of or increase the cost of insurance or result in uninsured losses; changes in governmental rules and fiscal policies which may result in adverse tax consequences, unforeseen increases in operating expenses generally or increases in the cost of borrowing; decreases in consumer confidence; government taking investments by eminent domain; various uninsured or uninsurable risks; the bankruptcy or liquidation of major tenants; adverse changes in zoning laws; the impact of present or future environmental legislation and compliance with environmental laws; the impact of lawsuits which could cause the Company to incur significant legal expenses and divert management’s time and attention from the day-to-day operations of the Company; and other factors that are beyond the Company’s control and the control of the property owners.

Any of the foregoing factors could adversely impact the return on and cash flows and values of the Company’s investments. In addition, property values can decline below their acquisition price or below their appraised, assessed or perceived values after the acquisition. Appraisals, if obtained, are only the appraiser’s opinion of the property values at a given point in time. Material declines in values could result in subsequent losses. The Company’s real estate based investments may be difficult to sell in an efficient and expeditious manner, and there can be no assurance that there will be a ready resale market when the Company elects to sell such investments.

 

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Risks Related to the Company’s Mortgage Loans

We will have limited control over our Portfolio Borrowers, which lack of control may affect the repayment of our Portfolio Loans.

Typically a Portfolio Borrower is structured as a single purpose entity or venture for the purpose of acquiring, improving, developing or holding the real property (a “Project”) collateralizing a Portfolio Loan. The Portfolio Borrower and the Project is managed exclusively by the principals of the Portfolio Borrower or its co-investors or affiliates.

Investors will have no opportunity to directly affect the management of the Portfolio Borrower or of the Project. The Company is also likely to have little opportunity to influence the management of the Portfolio Borrower or Project, except to the limited extent of imposing conditions to the draw of funds under a Portfolio Loan. Therefore, the successful operation of the Portfolio Borrower, the choice and terms of any junior lien Project financing, the success of the Project, the repayment of a Portfolio Loan, and the ability of the Portfolio Borrower to repay the Portfolio Loan depends greatly upon the skill, experience and efforts of the Portfolio Borrower or its principals in the acquisition, improvement, development, management and sale of the Project and in the management of the Portfolio Borrower. In the event the Project is not successfully completed, in addition to the inability of the Portfolio Borrower to repay such Portfolio Loan, the value of the Portfolio Loan collateral is likely to be impaired.

There is limited operating history for the Projects that secure our loans, increasing the risk that such Projects may not be able to repay our Portfolio Loans.

Although a Portfolio Borrower or its principals may be experienced real estate investors, the Project may have no operating or financial history. The prior success of Portfolio Borrower or its principals in connection with previous real estate investments are no assurance that the Portfolio Borrower will enjoy comparable success with respect to the Project collateralizing the Portfolio Loan. If a Portfolio Loan or Project collateral is impaired by the poor performance of a Portfolio Borrower, the Company’s ability to make payments on the Senior Notes may be impaired.

Our underwriting standards and procedures are more lenient than conventional lenders.

The Company will invest in Portfolio Loans with borrowers who will not be required to meet the credit standards of conventional mortgage lenders, which is riskier than investing in loans made to borrowers who are required to meet those higher credit standards. Because the Manager approves Portfolio Loans more quickly than some other lenders or providers of capital, there may be a risk that the due diligence the Manager performs as part of its underwriting procedures would not reveal the need for additional precautions. If so, the interest rate the Company charges and the collateral the Company requires may not protect the Company adequately or generate adequate returns for the risk undertaken.

The Projects for which we make a Portfolio Loan may not be able to be completed as planned, thereby increasing the risk that we will not be repaid.

Our Portfolio Loans are made to fund real property Projects, which Projects are often the subject of development plans by the Portfolio Borrower. Costs of planned improvements, development or operations of the Project securing the Portfolio Loan may exceed estimates, which may affect the Portfolio Borrower’s ability to complete the Project according to projections and budgets. Similarly, development plans may not be permissible under then-existing laws, ordinances, regulations and building codes. In either case, such events may affect the Portfolio Borrower’s ability to repay our Portfolio Loan, which may materially affect our ability to generate revenue.

 

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We may have difficulty protecting our rights as a secured lender.

The Company believes that its lending documents will enable it to enforce commercial arrangements with Portfolio Borrowers and other counterparties. However, the rights of Portfolio Borrowers, counterparties, and other secured lenders may limit the Company’s practical realization of those benefits. For example:

	·	Judicial foreclosure is subject to the delays of protracted litigation. Although the Company expects non-judicial foreclosure to be generally quicker, the Company’s loan collateral may deteriorate and decrease in value during any delay in foreclosing on it.
	·	The Portfolio Borrower’s right of redemption during foreclosure proceedings can deter the sale of the loan collateral and can for practical purposes require the Company to manage the property.
	·	The Company will be making loans in different states, with varying foreclosure laws, procedures and timelines. Depending on which state a Project is located, there may be more or less time, effort and cost associated with foreclosing on Portfolio Loans.
	·	Unforeseen environmental hazards may subject the Company to unexpected liability and procedural delays in exercising its rights.
	·	The rights of junior or senior secured parties in the same property can create procedural hurdles for the Company when it forecloses on loan collateral.
	·	The Company may not be able to pursue deficiency judgments after it forecloses on loan collateral.
	·	State and federal bankruptcy laws can prevent the Company from pursuing any actions, regardless of the progress in any of these suits or proceedings.
	·	The courts, particularly the bankruptcy courts, may unilaterally alter the contractual terms of the Company’s assets, including doing so to the detriment of the Company.

Care is exercised upon creation of the legal documents at the time of origination, or through thorough review of such documents in the event of acquisition, to ensure that as many bases as possible have been covered in the documents. However, in the event of default, it can be very difficult to predict with any certainty how courts will respond.

Our due diligence may not reveal all factors affecting an investment and may not reveal weaknesses in such investments.

There can be no assurance that the Manager’s due diligence processes will uncover all relevant facts that would be material to a lending decision. Before making a Portfolio Loan, the Manager will assess the strength of the underlying properties and any other factors that they believe are material to the performance of the Portfolio Loan. In making the assessment and otherwise conducting customary due diligence, the Manager will rely on the resources available to them and, in some cases, investigations by third parties.

Environmental liabilities may jeopardize our ability to realize repayment of our Portfolio Loans.

The Projects subject to our Portfolio Loans may become subject to liability for costs of cleanup of certain conditions relating to the presence of hazardous or toxic materials on, in or emanating from the Project securing our Portfolio Loan, and any related damages. Liability is often imposed without regard to whether the owner knows of, or was responsible for, the presence of the hazardous or toxic materials. These liabilities may interfere with the economic development of the subject Projects, and may interfere with the repayment of our Portfolio Loans.

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The repayment of our Portfolio Loans may be affected by other debt obligations associated with the Project.

While leveraged investments offer the opportunity for greater capital appreciation, such investments also involve a higher degree of risk. The Portfolio Borrower’s financing of a Project may involve varying degrees of leverage in order to provide greater financial return to the Portfolio Borrower, as a result of which recessions, operating problems and other general business and economic risks may have a more pronounced effect on the profitability or survival of such investments than if leverage were not employed. The Portfolio Borrower may also have to make debt service payments, including interest, which may fluctuate based on a spread above an underlying base rate. By its very nature, a variable interest rate will move up or down based on changes in the economy and other factors, all of which are beyond the control of the Portfolio Borrower. Accordingly, there can be no assurance that such rates will not rise significantly and, consequently, that a Portfolio Borrower would be required to pay more interest than is anticipated with respect to its other financing on the Project, thereby impairing its ability to repay the Portfolio Loan.

We may not be able to economically realize on a Project due to mechanic’s liens on the Project.

The Project may be subject to a mechanic’s lien, which entitles the holder of such a lien to foreclose on the Project. Most state laws provide that any person who supplies services or materials to a real estate Project may impose a lien against the Project securing any amounts owed to such person. Although the Portfolio Borrower may be required by the terms of the Portfolio Loan to utilize procedures to prevent the occurrence of mechanic’s liens (such as requiring mechanic’s lien releases prior to payment and issuing joint-party checks) no assurance can be given that mechanic’s liens will not appear against the Project. If a mechanic’s lien does appear, then it must be negotiated by the Portfolio Borrower in order to obtain its release or the person holding such lien will have the right to bring an action of foreclosure on the Project in order to satisfy the amount due under the lien.

We may not be able to economically realize on a Project if the Project becomes subject to eminent domain proceedings.

The Project or a portion of the Project could become subject to an eminent domain or inverse condemnation action. Such an action could have a material adverse effect on the operations or marketability of the Project, and, as a consequence, adversely affect the ability of the Portfolio Borrower to repay the Portfolio Loan. In addition, the value of the Project as collateral would be impaired and the Project may have insufficient remaining value to repay accrued interest and principal on foreclosure.

The Portfolio Loans are subject to credit risk associated with the Portfolio Borrower and the Project.

The financial failure of a Portfolio Borrower and default on a Portfolio Loan could result in a significant reduction in the Company’s income. The Company is relying solely on the value of the underlying collateral as security for the Portfolio Loan in such event. With respect to the collateral, the Company is subject to general economic risks with respect to its debt investments similar to those experienced by the Portfolio Borrower with respect to the Project.

We may have limited diversity with respect to our investments, increasing our risks.

The Company’s portfolio may become concentrated in a limited number of Portfolio Loans, increasing the vulnerability of the portfolio as compared with a portfolio that is more diversified in the number and location of Portfolio Loans and Portfolio Borrowers. If the Company is unable to diversify its investments by lending to a variety of Portfolio Borrowers and by diversifying the geographic and type of collateral, the Portfolio Loans will be dependent on the success of a limited number of Portfolio Borrowers and the Company’s assets may be concentrated in specific markets or collateral categories. If one or more Portfolio Borrowers or markets suffer adverse consequences, the Company’s financial condition and results of operations will be adversely affected.

Our remedies as a lender may be limited, limiting our ability to realize gain from our investments.

Portfolio Loans will generally be personal obligations of the principals of the Portfolio Borrower. In the event of a default under a Portfolio Loan, the Company is entitled to foreclose upon the property securing the Portfolio Loan and may seek a deficiency judgment against the principals, individually. A foreclosure action or other lender remedies may be subject to delays and additional expenses if defenses or counterclaims are interposed.

 

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Cross-collateralization may reduce the security available for the Portfolio Loans.

The repayment of one or more of the Portfolio Loans may be cross-collateralized by a direct or indirect interest in more than one Project. A Project is released as collateral as it is sold and the payment is made on the Portfolio Loan. However, there is no assurance that Projects will be sold in the order of their collateral value, or that the passage of time or changes in market conditions will preserve the value of remaining collateral. Therefore, the remaining Project may be insufficient collateral to provide protection in the event that the Portfolio Loan ceases to perform.

The Company’s investment may not be sufficiently protected in the event of damage to collateral.

Although the Company requires its Portfolio Borrowers to maintain adequate insurance coverage against liability for personal injury and property damage, such insurance may prove insufficient to cover any liabilities or casualty losses incurred by a Portfolio Borrower. Also certain risks may be uninsurable or may become uninsurable, or may become insurable only at prohibitive cost, such as the risk of property damage and general liability from earthquakes, floods, damage from terrorist activities, or certain environmental hazards. In addition, such risks may be insurable only in amounts that are less than the full market value or replacement cost of the relevant collateral. In addition to the unintentional loss of the collateral, the Portfolio Borrower may permit uninsured waste or other damage to the collateral by tenants, licensees or invitees. In the event of the occurrence of such risk or waste, the collateral may be substantially impaired or destroyed, and the potential loss to the Company in the event the applicable Portfolio Loan does not perform could be substantial.

The Company may become liable under laws regulating lenders.

In connection with the Portfolio Loans, the Company uses commercially reasonable efforts in reliance on qualified advisors to comply with laws and regulations applying to lenders in the relevant jurisdictions. However, such laws are not always clearly applicable to a particular loan transaction or investment structure, or they may change. In such event, the Company’s interest in a Portfolio Loan may be materially impaired; with the consequence that the Company’s ability to make payments on the Senior Notes may be materially impaired.

The Company may become subject to penalties for usury.

The structure of the Company’s Portfolio Loans is expected to comply with state usury laws and the laws of other relevant jurisdictions. However, usury laws and their exemptions are complex and may change. If, despite the Company’s reasonable efforts in reliance on qualified advisors to avoid such result, a Portfolio Loan made by the Company does not comply with applicable state usury laws, the Company may be responsible for payment of penalties and face the potential loss of its Portfolio Loan investment.

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FORWARD-LOOKING STATEMENTS

This Offering Circular includes forward-looking statements within the meaning of the federal securities laws. Forward-looking statements are generally identifiable by the use of words such as “may,” “should,” “expects,” “plans,” “believes,” “estimates,” “predicts,” “potential,” and other similar words or expressions. Such statements include information concerning our plans, expectations, possible or assumed future results of operations, trends, financial results and business plans, and involve risks and uncertainties that are difficult to predict and subject to change based on various important factors, many of which are beyond our control. Such factors include, but are not limited to, those discussed in the “Risk Factors” section of this Offering Circular. These and other important factors could cause actual results to differ materially from those contained in any forward-looking statement. You should not place undue reliance on our forward-looking information and statements. The forward-looking statements included in this Offering Circular are made as of the date of this Offering Circular, and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those projected in the forward-looking statements. All forward-looking statements contained in this Offering Circular are expressly qualified by these cautionary statements. Statements other than statements of historical fact are forward-looking statements.

The historical results described in this Offering Circular with respect to previous mortgage lending are historical only, and were influenced by available opportunities, diverse market conditions and other factors beyond the control of the Company. Any projections made in this Offering Circular are based on historical examples and the Company’s estimates of future conditions. There is no assurance that lending opportunities experienced in the past will occur in the future, that market conditions will be as favorable to the Company as they have been in the past, or that investors will enjoy returns on their investment comparable to those enjoyed by them or by others with respect to their participation in other investments sponsored by the Manager. The actual results experienced by the Company will differ, and such variation is likely to be material. Please see the section “Risk Factors” before deciding to purchase Senior Notes.

IN MAKING AN INVESTMENT DECISION, INVESTORS MUST RELY ON THEIR OWN EXAMINATION OF THE SENIOR NOTES, THE COMPANY AND THE TERMS OF THE OFFERING, INCLUDING THE MERITS AND RISKS INVOLVED. THE SENIOR NOTES HAVE NOT BEEN RECOMMENDED BY ANY FEDERAL, STATE OR FOREIGN SECURITIES COMMISSION OR REGULATORY AUTHORITY. FURTHERMORE, THE FOREGOING AUTHORITIES HAVE NOT CONFIRMED THE ACCURACY OR DETERMINED THE ADEQUACY OF THIS DOCUMENT. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

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USE OF PROCEEDS

The net proceeds to the Company from the sale of Senior Notes will be equal to the aggregate principal amount of Senior Notes we sell less our offering expenses. If we sell the maximum offering amount, which is $50,000,000, the net proceeds will be approximately $49,729,500, after deducting estimated expenses for the preparation, filing, printing, legal, accounting and other fees and expenses related to the offering of approximately $270,500. The Company intends to use the net proceeds from this offering to fund loans to borrowers and to fund the Company’s operating expenses and obligations. The Company has not identified the particular investments it will make. Accordingly, an investor must rely upon the ability of the Manager in making investments consistent with the Company’s investment objectives and policies. Although the Managing Directors have been successful in locating investments in the past, the Company may be unable to find a sufficient number of attractive opportunities to invest its committed capital or meet its investment objectives. The Company does not intend to use net proceeds for the purpose of repurchasing equity interests in the Company or repaying Junior Notes or Senior Notes. The Company does not anticipate any material changes to the use of proceeds described above in the event that less than all of the Senior Notes being qualified are sold and the net proceeds are subsequently reduced.

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BUSINESS

Overview

The Company was formed in 2009 as an Oregon limited liability company for the purpose of making commercial purpose loans by lending funds to real estate investors to finance the ownership, entitlement, development or rehabilitation of residential and commercial real estate throughout the United States. The Company has no employees and is managed by Iron Bridge Management Group, LLC, an Oregon limited liability company (the “Manager”), which is owned by Gerard Stascausky and operated by Gerard Stascausky and Sarah Gragg Stascausky (the “Managing Directors”). Gerard Stascausky and Sarah Gragg Stascausky combined bring to the Company over 20 years of investment banking experience and over 18 years of distressed real estate investment experience. The Manager provides Portfolio Loan origination and servicing services to the Company. See “Management” on Page 76 of this Offering Circular.

The Company’s primary business is to provide commercial purpose loans for the acquisition and rehabilitation of distressed residential and commercial real estate as well as to provide opportunistic financing for real estate development and construction. The Company’s primary source of funding is private debt and Bank Borrowings. The commercial purpose loans extended by the Company are based upon underwriting criteria the Manager has found to be successful in the past.

The Company primarily originates and structures its own loans, with such loans being secured by first lien deeds of trust or mortgages. However, the Company may also take title to properties (either directly or through a wholly owned subsidiary) to facilitate prompt acquisitions from trustees at auction, pre-foreclosure acquisitions from defaulting borrowers, or any other real estate acquisition in which the Company believes taking title to the property is in the best interest of the Company. The wholly owned subsidiary may provide the Company a level of liability protection on owned assets, while preserving the Company’s economic interests.

The Company’s investments are primarily in non-owner occupied real estate loans. The only owner-occupied residential loans that may be owned by the Company are purchases of existing, non-performing residential loans, with the objective of renegotiating terms with the resident owner or foreclosing on the property. The Company does not originate new owner-occupied residential loans of any kind.

Company Vision

We believe that the real estate finance industry is in the early stages of a major transformation that should create significant value for borrowers, investors and real estate finance companies. Technology and new securities laws should drive increased efficiency. For borrowers, this should mean lower interest rates and better service. For investors, this should mean superior risk-adjusted returns that are not available in the public markets. And for the innovative companies that lead this change, it should mean an opportunity to create value while effectively managing risk.

Background and Strategy

Real estate finance markets are highly fragmented, with numerous large, mid-size, and small lenders and investment companies, such as banks, savings and loan associations, credit unions, insurance companies, institutional lenders and private lenders all competing for investment opportunities. Many of these market participants experienced losses in the real estate market, which started to decline in 2006 and reached its bottom in 2012. As a result of credit losses and restrictive government oversight, many of these financial institutions are not participating in this market to the extent they had before the credit crisis. In addition, it appears that the number of banks and other institutional lenders willing to lend for the acquisition and rehabilitation of commercial and residential investment properties has decreased. In particular, we believe that banks and other institutional lenders are generally more reluctant to lend money secured by residential property until the property is constructed or fully renovated and either rented or ready for purchase by an owner-occupant. Developers particularly rely on private lending sources such as the Company to fill the need for financing between the time a property is purchased and the time, after construction or rehabilitation, when it is ready to be rented or sold. We believe the Company fills a significant gap by providing much needed financing of this type for areas with a growing need for such financing, and that profitable investment opportunities will be available to the Company based on the fragmented nature of the rehab lending market and the limited competition from banks and other institutional lenders.

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Why Private Lending Offers Asymmetrical Investment Returns

“The essence of investment management,” said legendary investor Benjamin Graham, “is the management of risks, not the management of returns.” We agree, and also believe that investors cannot be successful over the long term if they do not understand the relationship between risk and return within the context of the efficient market theory, which generally assumes two things: (1) information is ubiquitous and (2) capital moves freely. These two assumptions are critical in understanding the drivers of asymmetrical returns, which can be defined simply as higher rates of investment return per unit of risk than the efficient market theory would suggest.

The first assumption, “information is ubiquitous,” generally means that all investors know about all investments available and have analyzed all the information available related to those investments. In the public markets (e.g., publicly-traded stocks and bonds) this assumption is often true. For example, large investment funds with billions of dollars in investment capital often employ large staffs of analysts, each dedicated to specific industries or companies. The public companies they analyze are generally required by law to disclose material information to the public in a timely manner. When new information is made available, these analysts can quickly assimilate the information and invest accordingly. These conditions make information ubiquitous in the public markets, but these conditions generally do not hold true in the private lending industry for rehab and new construction projects.

The second assumption, “capital moves freely,” generally means that investors are able and motivated to allocate capital among investment opportunities in a way that always maximizes the investment return per unit of risk. Again, in the public markets, this assumption is often true. For example, large investment funds are generally competing to attract investment capital by earning a superior investment return relative to their peers and are therefore motivated to reallocate investment capital in order to maximize investment returns. In addition, the public markets are generally liquid and allow these institutional investors to buy and sell quickly with minimal transactional costs. These conditions allow capital to move freely in the public markets, but these conditions generally do not exist in the private lending industry for rehab and new construction projects.

By comparison, within the private lending industry information generally is not ubiquitous and capital generally does not move freely. For example, private lenders in Florida or New Jersey may not necessarily know about lending opportunities in Oregon or California. Moreover, even if those private lenders were made aware of these lending opportunities, the private lenders may not be interested or structurally capable of evaluating and funding the loans in the timeframes required. Further, capital generally does not move freely in the private lending industry for rehab and new construction projects. For example, the largest lenders in the real estate industry are banks, which are both government regulated and structurally challenged. Government regulations often dissuade banks from pursuing certain types of profitable loans in order to comply with larger risk management overlays. The banks are also often structured in ways that make them relatively slow in analyzing and funding loans. What this means is that the private lending industry for rehab and new construction projects is fragmented and inefficient and does not comply with the efficient market theory’s assumptions of ubiquitous information flow and free movement of capital. This inefficiency provides an opportunity for participants in the private lending industry to earn asymmetrical investment returns, or, in other words, a higher rate of return per unit of risk versus public market investments as indicated in the following graph.

 

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Defensive Attributes of the Company’s Business Model

While there can be no guaranty that investors in the Company will not lose some or all of their investment, we believe that the Company’s business model has certain defensive attributes that may allow the Company to perform relatively well in adverse economic environments. The following is a list of defensive business model attributes that we believe have allowed the Company to perform relatively well between 2009 and 2017. There can be no assurance that these attributes would provide the same or any level of protection in the future.

The Company does not rely on increases or decreases in real estate prices. The Company’s investment returns are primarily derived from the interest payments and fees paid by the Company’s Portfolio Borrowers who have generally demonstrated an ability to find profitable projects in various economic environments. We believe this is one of the reasons why the Company’s profitability and investor returns have remained stable through depreciating, flat and appreciating real estate markets since 2009.

The Company generally makes short term loans of 12 months or less that enable both the Company and its Portfolio Borrowers to adapt quickly to changing economic conditions. For example, if real estate prices soften and resale activity slows down, some of our Portfolio Borrowers may break even or lose money on current Projects because their estimated resale prices may prove to have been too optimistic. However, because these are short-term Projects with defined exit strategies, our Portfolio Borrowers are often able to adapt quickly by buying the next Project at a lower price to account for changing market conditions.

Changes in interest rates do not require the Company to reprice its Portfolio Loans, minimizing interest rate risk. The Company has the intent and ability to hold its Portfolio Loans to maturity. Therefore, Portfolio Loans are stated at their outstanding unpaid principal balance with interest thereon being accrued as earned. Changes in interest rates do not require the Company to reprice its Portfolio Loans. However, changes in interest rates can create reinvestment risk related to changes in the rate of return available on new Portfolio Loans made by the Company.

The Company’s Portfolio Borrowers are more price setters than price takers. Because our Portfolio Borrowers’ Projects are short-term, and their profits come primarily from the value created in the Project, we believe our Portfolio Borrowers are more sensitive to completing and selling their Projects quickly than they are to the current level of real estate prices. For example, between 2009 and 2012, when real estate prices were in decline, many of the Company’s Portfolio Borrowers were buying properties from foreclosure auctions at very low prices, rehabbing the houses, and then listing the houses for sale at prices that were often lower than competing listings, resulting in quick sales.

 

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The Company’s loan portfolio is primarily secured by residential real estate, which we believe to be a more defensive asset class relative to assets correlated to other sectors of the economy. Real estate is a well-known inflation hedge, but what’s more important is that, in our view, the Federal Reserve and other policymakers are likely to prioritize the health of the residential real estate market over other sectors of the US economy. The simple reason is that consumption is approximately 70% of U.S. gross domestic product and housing is the largest single investment for most consumers. Accordingly, we believe that it is unlikely that policymakers will allow the residential real estate market to suffer for an extended period without taking action. The same cannot be said for other sectors of the economy, such as the oil and gas industry which has experienced a major decline in energy prices since mid-2014 that has led to significant capital spending reductions and industry layoffs. However, from an economic perspective the benefits of lower energy prices transmitted through increased consumer spending generally appear to outweigh the negative effects of oil industry contraction.

The Company’s business model generates strong and stable monthly recurring revenues, which means the Company is well positioned to cover interest payments. For the year ended December 31, 2017, the Company generated revenues of $11.6 million and combined interest expense of $4.2 million related to its private debt and Bank Borrowings. Revenues were 2.8 times the amount needed to cover this combined interest expense, with average portfolio leverage of 73% during 2017. We believe that this level of interest coverage provides a significant layer of loan portfolio protection that should help safeguard investor capital during an adverse economic event.

Investor capital is further protected by the value of the underlying real estate collateral. As of December 31, 2017, the estimated “as-is” value of the Company’s real estate collateral was $98.9 million, which secured the approximately $68.4 million loan portfolio. The value of the real estate collateral was approximately 1.9 times the amount necessary to pay off our private debt and Bank Borrowings combined ($52.8 million) and provided a combined loan-to-value of 53%. Similarly, the value of the real estate collateral was approximately 1.4 times the amount needed to pay off our entire capital stack – equity, private debt and Bank Borrowings combined ($73.0million), providing a loan-to-value of 74%. We believe that this level of real estate asset coverage and loan-to-value provides another important layer of portfolio protection that should help safeguard investor capital during an adverse economic event. See “As-Is Loan-to-Value and Asset Coverage Based on Percentage Completion” on Page 52 for additional information regarding loan-to-value analysis and the method of estimating “as-is” value.

Portfolio Loan Characteristics

Project Type. The primary focus of the Company’s lending activities is on single-family residential rehab and new construction projects. As described above, the Company believes that this market is underserved by banks and other institutional lenders. In addition, the relatively short-term nature of these projects (12 months or less) allows the Company and its Portfolio Borrowers to adjust quickly to changing market conditions.

 

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The following table provides information about the distribution of the Company’s loan portfolio by project type segmented further by number of loans and the unpaid principal balance (“UPB”) of those loans.

As of June 30, 2018 the percentage of UPB categorized by project type consisted of 83% Single Family Residential Rehab Projects (193 loans), 15% Single Family Residential New Construction Projects (25 loans), 2% Multi-Family Residential Rehab Projects (1 loans), 0% Multi-Family Residential New Construction, 0% Commercial and 0% Land Entitlements.

By comparison, as of June 30, 2017 the percentage of UPB categorized by project type consisted of 73% Single Family Residential Rehab Projects (202 loans), 22% Single Family Residential New Construction Projects (30 loans), 4% Multi-Family Residential Rehab Projects (16 loans), 1% Multi-Family Residential New Construction (1 loan), 0% Commercial and less than 0% Land Entitlements.

As of December 31, 2017, the percentage of UPB categorized by project type consisted of 74% Single-Family Residential Rehab (187 loans), 24% Single-Family Residential New Construction (34 loans), 2% Multi-Family Residential Rehab (11 loans), 0% Multi-Family Residential New Construction, 0% Commercial and 0% Land Entitlements.

By comparison, as of December 31, 2016 the percentage of UPB categorized by project type consisted of 69% Single-Family Residential Rehab (184 loans), 21% Single-Family Residential New Construction (32 loans), 7% Multi-Family Residential Rehab (21 loans), 1% Multi-Family Residential New Construction (1 loan), 0% Commercial and 2% Land Entitlements (6 loans).

By comparison, as of December 31, 2015, the percentage of UPB categorized by project type consisted of 64% Single-Family Residential Rehab (190 loans), 25% Single-Family Residential New Construction (47 loans), 10% Multi-Family Residential Rehab (21 loans), 0% Multi-Family Residential New Construction, 0% Commercial and 1% Land Entitlements (5 loans).

 

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From 2013 through 2015 the Company modestly increased the amount of loans it made for single-family and multi-family new construction. This trend reflects the general improvement in the real estate market over that time and a corresponding shift in the business models of our borrowers from fixing distressed properties purchased through foreclosure sales or from bank owned inventory to more value-added projects, such as square footage additions or new construction. During 2016 and 2017, the Company’s single-family and multi-family new-construction loans, in aggregate, remained consistent at less than 25% of loan portfolio UPB. During the first six months of 2018, the Company chose to decrease the number of single-family and multi-family new-construction loans in favor of single family residential rehab projects.

It is important to point out that the Company does not make loans for land entitlement purposes only. These land entitlement loans represent phase one of two phase projects that require land entitlement to be completed prior to new construction commencing on either single-family or multi-family residential structures.

Geographical Distribution. During 2015, the Company made fewer loans in Arizona, increased its lending activity in the states of Colorado and Illinois, and began lending in Indiana and Pennsylvania. During 2016, the Company maintained stable lending activity across its existing geographies and began lending in Florida, Massachusetts, New Jersey, North Carolina, Oklahoma and South Carolina. During 2017, the Company made fewer loans in Illinois and began lending in Tennessee and Virginia.

Expanding its loan programs to additional states, allows the Company to add geographic diversification to the loan portfolio and to rebalance the loan portfolio toward those geographies that offer higher rates of return per unit of risk. Some of the variables evaluated by the Company in making the decision to expand or contract in a specific geographic market include the competitive pricing pressure from competing lenders, availability of borrower projects, the margins on those borrower projects, state laws related lending and foreclosure, and trends in regional economic activity.

The Company continues to experience steady loan demand and stable real estate resale activity. However, the real estate market is increasingly being driven by regional economics and less so by the macro boom and bust cycle of recent years. While real estate is generally benefiting from improvements in employment and low interest rates, the bounce off the bottom for real estate prices has slowed and regional economics are becoming a larger factor in local real estate trends. For this reason, the Company believes that increasing its geographic diversification and having the ability to rebalance its loan portfolio between geographies is important to effectively manage risk.

 

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The following table provides the geographic distribution of the Company’s loan portfolio by state segmented further by the number and unpaid principal balance of loans (“UPB”) that were active at the end of the period and those loans that paid off during the period.

		As of or for the Six Months Ended June 30,								As of or for the Year Ended December 31,
		2018				2017				2017				2016				2015
Arizona
Number of active loans, end of period			—				—				—				—				—
Percentage of total UPB			—				—				—				—				—
Number of paid off loans, during period			—				—				—				4				2
Percentage of paid off UPB			—				—				—				<1	%			<1	%
California
Number of active loans, end of period			48				55				46				48				46
Percentage of total UPB			46	%			34	%			39	%			34	%			31	%
Number of paid off loans, during period			38				32				63				60				53
Percentage of paid off UPB			39	%			31	%			28	%			30	%			36	%
Colorado
Number of active loans, end of period			12				11				10				7				13
Percentage of total UPB			7	%			6	%			6	%			7	%			10	%
Number of paid off loans, during period			6				5				11				13				7
Percentage of paid off UPB			5	%			10	%			8	%			8	%			5	%
Connecticut
Number of active loans, end of period			2				—				—				1				4
Percentage of total UPB			<1	%			—				—				<1	%			1	%
Number of paid off loans, during period			—				1				1				3				4
Percentage of paid off UPB			—				<1	%			<1	%			<1	%			1	%
Florida
Number of active loans, end of period			4				2				5				1				—
Percentage of total UPB			<1	%			<1	%			1	%			<1	%			—
Number of paid off loans, during period			4				2				4				3				—
Percentage of paid off UPB			1	%			<1	%			<1	%			<1	%			—
Georgia
Number of active loans, end of period			5				2				1				—				—
Percentage of total UPB			1	%			<1	%			<1	%			—				—
Number of paid off loans, during period			1				2				5				—				—
Percentage of paid off UPB			<1	%			<1	%			<1	%			—				—
Illinois
Number of active loans, end of period			41				62				55				71				86
Percentage of total UPB			11	%			16	%			13	%			17	%			18	%
Number of paid off loans, during period			35				42				79				96				33
Percentage of paid off UPB			9	%			13	%			15	%			14	%			5	%
Indiana
Number of active loans, end of period			1				1				3				3				2
Percentage of total UPB			<1	%			<1	%			<1	%			<1	%			<1	%
Number of paid off loans, during period			3				3				3				—				1
Percentage of paid off UPB			1	%			<1	%			<1	%			—				<1	%
Massachusetts
Number of active loans, end of period			—				3				3				2				—
Percentage of total UPB			—				1	%			1	%			1	%			—
Number of paid off loans, during period			5				—				—				1				—
Percentage of paid off UPB			2	%			—				—				<1	%			—
New Jersey
Number of active loans, end of period			7				4				3				—				—
Percentage of total UPB			1	%			<1	%			<1	%			—				—
Number of paid off loans, during period			4				4				8				4				—
Percentage of paid off UPB			1	%			<1	%			1	%			<1	%			—
North Carolina
Number of active loans, end of period			3				1				2				1				—
Percentage of total UPB			1	%			<1	%			<1	%			<1	%			—
Number of paid off loans, during period			—				1				2				1				—
Percentage of paid off UPB			—				<1	%			<1	%			<1	%			—

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As of June 30, 2018, the geographic concentration of active portfolio loans of 1% or more of the UPB in any state was as follows: California 46%, Colorado 7%, Georgia 1%, Illinois 11%, New Jersey 1%, North Carolina 1%, Oregon 20%, South Carolina 1%, Texas 3%, Virginia 1% and Washington 6%.

This compares to June 30, 2017, when the geographic concentration of active portfolio loans of 1% or more of the UPB in any state was as follows: California 34%, Colorado 6%, Illinois 16%, Massachusetts 1%, Oregon 29%, Pennsylvania 1%, Texas 1% and Washington 10%.

As of December 31, 2017, the geographic concentration of active Portfolio Loans of 1% or more of the UPB in any state was as follows: California 39%, Colorado 6%, Florida 1%, Illinois 13%, Massachusetts 1%, Oregon 24%, Pennsylvania 1%, Texas 2%, Virginia 1% and Washington 9%.

This compares to December 31, 2016, when the geographic concentration of active Portfolio Loans of 1% or more of the UPB in any state was as follows: California 34%, Colorado 7%, Illinois 17%, Massachusetts 1%, Oregon 29%, Pennsylvania 1%, Texas 1% and Washington 10%.

This compares to December 31, 2015, when the geographic concentration of active Portfolio Loans of 1% or more of the UPB in any state was as follows: California 31%, Colorado 10%, Connecticut 1%, Illinois 18%, Oregon 28% and Washington 11%.

Borrowers. The Company’s Portfolio Borrowers are often comprised of one to three member teams that form a company and take title to Projects in their company name. The team members usually have prior experience in real estate development, construction, finance or sales. For example, a common three-person team might include a real estate agent, general contractor and financier, each contributing their expertise to the team. The real estate agent might be tasked with identifying attractive Projects, making suggestions regarding what capital improvements should be made to the Projects and helping to market and sell the Projects. The contractor might be tasked with assessing the cost, complexity and time necessary to make the planned capital improvements to the Project and managing that construction process. The financier might be tasked with managing the lender relationships, equity investor relationships, if any, and handling all back office accounting.

 

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Between 2009 and 2015, the Company did not pursue a formal marketing or advertising program to grow its base of Portfolio Borrowers. The growth in the number of Portfolio Borrowers came almost exclusively through word of mouth. However, beginning in 2016, the Company implemented a marketing and advertising plan, which has helped the Company identify qualified Portfolio Borrowers and advantageous lending opportunities in each geographic market.

It has been our experience that providing Portfolio Borrowers with exceptional service leads to business referrals, which we believe is the best form of marketing. In addition, because our Portfolio Borrowers are often repeat customers, the value of each Portfolio Borrower relationship is much higher than it would be if the Portfolio Borrowers were not repeat customers.

The following table provides information regarding borrower concentrations as of the dates indicated.

As of June 30, 2018, the portfolio consisted of 219 active loans provided to 133 borrowers. The average number of loans per borrower was 1.6 loans. The largest borrower represented 7% of UPB, while the top 3 borrowers represented 19% of UPB.

By comparison, as of June 30, 2017, the portfolio consisted of 249 active loans provided to 160 borrowers. The average number of loans per borrower was 1.6 loans. The largest borrower represented 6% of UPB, while the top 3 borrowers represented 13% of UPB.

As of December 31, 2017, the portfolio consisted of 232 active loans provided to 151 borrowers. The average number of loans per borrower was 1.5 loans. The largest borrower represented 8% of UPB, while the top 3 borrowers represented 17% of UPB.

This compares to December 31, 2016, when the portfolio consisted of 244 active loans provided to 156 borrowers. The average number of loans per borrower was 1.6 loans. The largest borrower represented 6% of UPB, while the top 3 borrowers represented 13% of UPB.

This compares to December 31, 2015, when the portfolio consisted of 264 active loans provided to 150 borrowers. The average number of loans per borrower was 1.8 loans. The largest borrower represented 4% of UPB, while the top 3 borrowers represented 10% of UPB.

The average number of loans per borrower has remained consistent over time. However, the loan portfolio concentration from the top three borrowers increased during 2017 and the first six months of 2018, a result of the Company’s effort to lower its loan pricing to gain and retain higher quality borrowers. These higher quality borrowers generate more loans and larger loans, on average, and have been in states with higher property prices.

 

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Loan Term. All of the Company’s loans are made with maturity dates of 12 months or less. However, it is the Company’s policy to provide borrowers, whose loans are not in default, with six-month loan extensions, as needed, to allow more time to finish projects. Loans categorized with aging of 12+ months reflect those loans with loan extensions.

As mentioned above, the primary focus of the Company’s lending activities is on single-family residential rehab and new construction projects. We believe that banks and other institutional lenders underserve this market, which provides the Company with the opportunity to earn attractive rates of return per unit of risk. In addition, the relatively short-term nature of these projects allows the Company and its Portfolio Borrowers to adjust quickly to changing market conditions. See “Defensive Attributes of the Company’s Business Model” above for additional disclosures.

The following table sets forth the distribution of loans by age at the dates indicated:

As of June 30, 2018, the age distribution of the 219 active Portfolio Loans was as follows: 138 loans within 0-6 months (63% of the unpaid principal balance (“UPB”)), 31 loans within 6-9 months (10% of UPB), 17 loans within 9-12 months (7% of UPB) and 33 loans greater than 12 months (20% of UPB).

By comparison, as of June 30, 2017 the age distribution of the 249 active Portfolio Loans was as follows: 142 loans within 0-6 months (52% of UPB), 24 loans within 6-9 months (9% of UPB), 24 loans within 9-12 months (9% of UPB) and 59 loans greater than 12 months (30% of UPB). The number of loans that were greater than 12 months in age included non-performing loans but also reflected an increase in the number of larger rehab and new construction projects financed, which were expected to take approximately one year to complete.

As of December 31, 2017, the age distribution of the 232 active Portfolio Loans was as follows: 123 loans within 0-6 months (42% of UPB), 33 loans within 6-9 months (13% of UPB), 18 loans within 9-12 months (13% of UPB) and 58 loans greater than 12 months (32% of UPB).

 

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This compares to December 31, 2016, when the age distribution of the 244 active Portfolio Loans was as follows: 120 loans within 0-6 months (40% of UPB), 38 loans within 6-9 months (14% of UPB), 24 loans within 9-12 months (11% of UPB) and 62 loans greater than 12 months (34% of UPB).

This compares to December 31, 2015, when the age distribution of the 264 active Portfolio Loans was as follows: 166 loans within 0-6 months (54% of UPB), 45 loans within 6-9 months (19% of UPB), 23 loans within 9-12 months (10% of UPB) and 30 loans greater than 12 months (17% of UPB).

Loan Turnover. The following table provides information associated with the Company’s Portfolio Loan turnover for the periods shown: